Download e-book for iPad: Asset Allocation and International Investments by Greg N. Gregoriou (eds.)

By Greg N. Gregoriou (eds.)

ISBN-10: 0230626513

ISBN-13: 9780230626515

ISBN-10: 1349285455

ISBN-13: 9781349285457

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1 Economic importance of regimes The economic importance of regimes is a very relevant issue for the appraisal of regime-switching strategies. We measure this “importance” as utility costs that an investor bears, when he/she gives up the optimal strategy and follows instead a suboptimal one. More precisely, we are interested in the monetary compensation c, also called certainty equivalent compensation, that makes an investor with time horizon T indifferent between the suboptimal weights α− and the optimal weights α∗ .

As for the unhedged strategy, the three regimes can be referred to as bear state, low correlation state, and high correlation state. The low correlation state can be interpreted as a transitory state. 4 DISCUSSION With the empirical specification at hand, we next discuss some of the implications of regime switching on asset allocation. With regard to the numerical calculation of the optimal portfolio strategies, we use a Monte Carlo simulation with sample size Z = 30,000. Furthermore, for all calculations, we suppose that the investor has a risk aversion parameter equal to γ = 5.

LR1;1 tests for serial correlation of lag one, LR2;1 for serial correlation of lag one and two, and LR2;2 for linear and squared serial correlation up to lag two. The latter is a test for omitted volatility dynamics. 1 We find that the Jarque–Bera statistic is reduced substantially by the use of regime-switching models. For example, we find that the Jarque–Bera statistics of the UK excess returns are above 2,000. In contrast, under the chosen specifications of the regime-switching models, the statistics for the UK are mainly below 20 during the period of the out-of-sample test.

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Asset Allocation and International Investments by Greg N. Gregoriou (eds.)


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